Monday, 21 August 2017Two weeks after Ray Dalio warned in his latest letter to Bridgewater clients that the right trade in the current environment is to buy gold in case *"things go badly", *the head of the world's biggest hedge fund is out with his gravest warning yet, saying that he is "concerned about growing internal and external conflict leading to impaired government efficiency." In his LinkedIn post, he writes that he "continues to closely watch how conflict is being handled a guide, *and I’m not encouraged.”*

Echoing a similar warning issued just days ago from perhaps the most prominent name in all of finance, Lord Jacob Rothschild, the head of the world's biggest hedge fund says that “*conflicts have now intensified to the point that fighting to the death is probably more likely than reconciliation" *and in a stark comparison to the days prior to World War II, observes that "*politics will probably play a greater role in affecting markets than we have experienced any time before in our lifetimes but in a manner that is broadly similar to 1937*."

Basically, Ray Dalio just compared the current political environment to the days just prior to the outbreak of World War II. That is probably not a coincidence.

His full LinkedIn note:

*I believe that a) most realities happen over and over again in slightly different forms, b) good principles are effective ways of dealing with one's realities, and c) politics will probably play a greater role in affecting markets than we have experienced any time before in our lifetimes but in a manner that is broadly similar to 1937. *

I'm essentially an economic mechanic who focuses on how reality works by studying the cause:effect relations and how they played out in history to help me bet on what's likely to occur. For reasons previously explained in "Populism..." it seems to me that we are now economically and socially divided and burdened in ways that are broadly analogous to 1937. During such times conflicts (both internal and external) increase, populism emerges, democracies are threatened and wars can occur. I can't say how bad this time around will get. I'm watching how conflict is being handled as a guide, and I'm not encouraged.

History has shown that democracies are healthy when the principles that bind people are stronger than those that divide them, when the rule of law governs disputes, and when compromises are made for the good of the whole --- and that democracies are threatened when the principles that divide people are more strongly held than those that bind them and when divided people are more inclined to fight than work to resolve their differences. *Conflicts have now intensified to the point that fighting to the death is probably more likely than reconciliation.*

Average numbers hide the depths of the divisions. For example, by looking at average figures, one might conclude that the United States economy is doing just fine, yet when one looks at the numbers that comprise those averages, it's clear that some are doing extraordinarily well and others are doing terribly, with gaps in wealth and income being the greatest since the 1930s.

Largely as a function of these economic differences and differences in the principles that people believe most deeply in, we are seeing large and increasingly firm political differences, which are apparent only by looking below the averages. For example, Donald Trump's approval rating of 35% is a result of 79% support among Republicans and 7% among Democrats (Gallop). Of those who approve of President Donald Trump, 61% say they can't think of anything Trump could do that would make them disapprove of his job as President, and 57% who disapprove of Trump say they are never going to change their minds on the President's job performance (Monmouth). Similarly 40% of those polled (PRRI) would favor Donald Trump’s impeachment, which consists of 72% of Democrats and 7% of Republicans, and most of them won't change their minds.

*In other words, the majority of Americans appear to be strongly and intransigently in disagreement about our leadership and the direction of our country. They appear more inclined to fight for what they believe than to try to figure out how to get beyond their disagreements to work productively based on shared principles. *

So, where does that leave us?

*While I see no important economic risks on the horizon, I am concerned about growing internal and external conflict leading to impaired government efficiency (e.g. inabilities to pass legislation and set policies) and other conflicts. *

I of course hope that the principles that bind us together are stronger than the ones that divide us. I believe that this is a time when it is especially important for us a) to be explicit about what our principles are in order to be clear about what we agree and disagree on, b) to practice the art of thoughtful disagreement, and c) to respect our ways of getting past our disagreements so we can start rowing in the same direction. *I believe that how well this is done will have a greater effect on the economy, markets and our overall well-being than classic monetary and fiscal policies, so I continue to closely watch how conflict is handled while tactically reducing our risk to it not being handled well.*